It’s Not Quite A Crystal Ball, But It’s Damn Close…
Dear Penny Stock Millionaire,
Patterns are everywhere in life. If you think about it, recognizing patterns helps you make sense of the world. As a trader, seeing and understanding patterns can give you an advantage. Over the last two decades, I’ve used patterns to earn millions in profit.
Continuation patterns are yet another type of chart pattern you should study and put to use in your trading.
What Are Continuation Patterns?
As a day trader, I use technical analysis most of the time. l look for price support and resistance, breakouts, morning panics — which you can see on a stock’s chart. As you continue to study, you’ll begin to see patterns on the charts.
A continuation pattern is when the trend in the price action is broken by a period of consolidation and then the trend continues. During the consolidation period, there are common ‘shapes’ visible on the chart.
Why does the price go through a period of consolidation?
It has to do with supply vs. demand and it also relates to taking profits or cutting losses. These are what cause market fluctuation. Each trade has two sides, right? Let’s say there’s some awesome news catalyst that causes a clean spike of a stock. Maybe the company announced higher-than-expected earnings plus a deal signed with a much bigger company.
At some point during the spike, some traders will close out their positions to take profits. So you might get 5 minutes of selling. The price drops a small amount. Not to be outdone, some traders jump in and start to buy again. They believe the stock will keep moving the direction of the trend. So the next candle is an upward price trend.
This period of consolidation can last anywhere from several minutes to several weeks. The price tends to stay within a range and the range forms one of the shapes I’ll show you later in this post. After the consolidation period, the trend continues in its original direction. At least that’s the theory.
Here’s a simple example. Say there’s been steady upward price movement on a stock all morning. Then, in the early afternoon, there’s a period of sideways price action. Trading volume drops and the price stays in a small range. Then, there’s a late afternoon spike in volume and the price continues its upward trend.
Some traders don’t consider short term patterns to ‘count’ as continuation patterns. Whatever. That’s a bunch of self-serving BS. Patterns happen in all different time frames.
You might see a flag pattern on a one-year daily candlestick chart but it’s not clear on a one-month or 15-minute chart. The best swing trader I know looks for pattern formations in different time frames in order to confirm his trading thesis.
Benefits of Using Continuation Patterns
Why do continuation patterns matter? Because they can give you an idea of future price action for a stock.
Before I go any further, it’s important that you know that this isn’t an exact science. Consolidation periods don’t always turn into continuation patterns. There are reversal patterns, too.
The good news is, I teach my students rules (and some of them come up with their own rules) to trade by. And as long as you follow the rules and stick to your trading plan, you’re better prepared to tackle whatever the market throws your way.
Continuation Patterns Every Trader Should Know
Now let’s check out the top continuation patterns used by many traders.
Keep in mind that I trade and teach day trading (as opposed to long-term investing or swing trading), so the examples I show will be based on shorter time frames. But you could pore over a few longer-term charts (like a one-year chart with daily candles) and see these patterns in those time frames, as well.
The point is for you to be able to recognize the patterns, learn how to plan a trade around the pattern, and then use them to your advantage.
By the way, I recommend using Japanese candlestick charts. I use candlestick charts when I trade because I like all of the information contained in the chart. They also make it easy to see continuation patterns.
Rectangles form when the trend, either up or down, stops temporarily. Price action consolidates within parallel support and resistance lines. Then, after the period of consolidation, the trend continues in its original direction.
Example of a Rectangle Continuation Pattern
Take a look at the Cronos Group, Inc. (Nasdaq: CRON) chart below. The parallel blue lines show where the trend paused before continuing on. There’s an argument to be made for this as an example of a wedge or even a triangle depending on how you draw the lines. Don’t let that get in the way of the point.
CRON 2 minute candle chart: Rectangle continuation pattern
Notice the price range was tested several times both top and bottom before the upward trend continued.
The wedge is another continuation pattern that’s pretty easy to see on a candlestick chart once you get some practice. Look for a flat support line on one side of the wedge. Depending on whether it’s a bullish or bearish wedge, the opposing support or resistance line approaches the flat line at an angle.
Examples of Wedge Continuation Patterns
Check out the Hemp Americana, Inc. (OTCMKTS: HMPQ) chart below. This chart is interesting because there was a morning panic several days in a row. The first two days, the selloff was followed by a wedge-shaped consolidation. The third day it was more of a rectangle.
HMPQ 10 minute candlestick chart: Wedge continuation pattern
The Bottom Line
As you know, nothing is certain in the stock market. But these continuation patterns can help you to read into what might happen, and that can give you a serious leg up when you execute your trades.
It takes practice though. Even if you know what patterns to look for, you still need to be able to identify them. Of course, identifying a pattern in and of itself won’t make you money. Once you identify a pattern you need to know what to do with the pattern to make yourself money.
The key to making money with patterns is something I’ll cover tomorrow.
In tomorrow’s issue, I’ll go over 2 more continuation patterns to look out for, as well as a few tips to help you use them for maximum profit potential.
Editor, Penny Stock Millionaires